How Independent Are You?

Q: I am planning on doing consulting work for some associates who've started a retail business. I will be handling their advertising and promotions as an agency. They're willing to set me up as an independent contractor and give me a 1099 at the end of the year. Should I go with that option, or should I file for a business license and invoice them? If I go the 1099 route, how do I go about charging fees? I'd like to bill customers on a per-project basis.

Name withheld

A: Because you're a sole proprietor, you'll report the income reflected on the Form 1099s you receive on Schedule C of your 1040 tax return. But that's not all-you'll also need to make estimated tax payments if you'll owe $1,000 or more for the year. Estimated taxes need to cover both income tax and the federal self-employment tax-Social Security and Medicare.

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It's a good time to start your own business, so you should obtain a business license and seek out more than one client. Billing by the project is a good idea, because it clearly differentiates you from an hourly employee. And by all means, invoice your clients rather than submitting a time sheet like an employee.

Don't participate in benefits offered to employees by the retail business, such as a health insurance plan. As companies increasingly rely on consultants, freelancers and independent contractors, the IRS and state tax agencies want to be sure such arrangements are not just a way for both parties to avoid paying conventional employee taxes. Should the IRS decide that you're an employee masquerading as an independent contractor, both you and the client will suffer.

As a business owner, you're able to take many valuable deductions. For details, and to download forms and publications, log on to http://www.irs.gov/businesses/small/index.html.

Paul and Sarah Edwards' most recent book is Changing Directions Without Losing Your Way. Send them your start-up questions at www.workingfromhome.com.